EUR 850.00 For Business Accounts Only

Morningstar | Cardinal Reports a Decent 4Q as It Continues to Realign Its Operations

Even though there may be some material changes over the next several years  to how the various parts of the U.S. pharmaceutical market operates, the need to source and deliver drugs in a cost-effective and efficient manner will not change. We believe this fundamental factor has formed a strong foundation for Cardinal, as its core drug wholesaling operations will be needed by both drug manufacturers and retail pharmacies no matter how any market dynamics shift. Thus, we are reiterating our wide moat rating and our $82 fair value estimate for the drug distributor.

Cardinal reported some stabilization in its operations as generic deflation continued to moderate and the firm reorganizes both its operations. Part of this reorganization includes the firm refocusing much of its managerial bandwidth and asset investment toward building more efficiency and stabilization into its core pharmaceutical wholesale segment. This is a major change from the firm’s previous strategy of expanding its business portfolio and global reach and we applaud the new management team on this strategy. We have modeled modest profit improvements for this segment as we model operating margins to expand between fiscal 2018 to fiscal 2022 by only 25 basis points to 2.48%. We believe this reflects a conservative outlook and incorporates greater infrastructure efficiency, modest pricing spread, and less variability tied to branded pricing.

We remain unenthusiastic about Cardinal's push into medical equipment manufacturing/distribution and believe the previous management team’s efforts to expand into this business was a strategic misstep. Although global healthcare spending should remain robust over the foreseeable future, this is not the case for the low-tech medical and surgical products, which generally are commodities. The main focus for this segment over the near-term is improving the Cordis business lines which are not necessarily among the top-tier within their categories. We believe Cardinal has reset its pricing for these products in order to clear its current inventory backlog--pressuring profits. We have feared this dynamic would eventually develop for Cardinal and have long been negative toward its previous capital allocation policies and non-drug wholesaling acquisitions. From our perspective, the best course for management may be to pursue alternative strategies for these assets and to divest of much of its medical supply operations that do not share much synergy with the wide-moat drug distribution operations.

Cardinal’s fairly new CEO, Mike Kaufman, stated on the earnings call that the process of reevaluating the firm’s operations and refocusing efforts on process improvements will continue into fiscal 2019. We believe this strategy will be a positive over the long-term and the near-term headwinds the firm currently faces will eventually abate. We believe the greater focus on optimizing its drug wholesaling operations and expansion of specialty pharmaceutical operations will bolster Cardinal’s results and shareholder value beyond fiscal 2019. Cardinal is position as a critical cog within the global pharmaceutical supply chain and this dynamic will provide it the opportunity to produce significant economic profits over the long-term. Thus the current discount in the firm’s stock price presents an opportunity for investors with long-term time horizons to own a wide-moat business at a significant discount.